Journal of Financial Planning - March 2006

The widespread adoption by the insurance industry of the 2001 mortality tables in the coming years generally won't have much of an impact on consumers in lowering premiums—but where it will have an impact, the effect will be negative.

The Mortality Table Is Coming...So?

by Peter Katt, CFP, LIC

The mortality table is coming—the mortality table is coming! Thunder insurance agents nationwide! Quick! Find your life insurance policies and...have a cup of coffee and go back to what you were doing. Despite claims to the contrary, the widespread adoption of the 2001 Commissioner's Standard Ordinary (CSO) mortality table in life insurance pricing during the next few years will have little impact on existing life insurance. This doesn't mean that many existing policies are in great shape pricing-wise—they aren't—but overpriced (relative to current experience) policies aren't due to the development of a new mortality table. They are due to companies habitually creating new policies with better pricing than the old, while letting older policies' pricing become uncompetitive.

Mortality tables of one form or another have been around as long as the life insurance industry itself. They have historically been used in establishing premiums, calculating dividends, calculating reserves, and determining life expectancies and probabilities of survival.

The American Experience table was published in 1868 and was in widespread use throughout the life insurance industry until the CSO tables were established. The 1941 CSO table (which was actually introduced in 1948) was the inaugural table; the 1958 CSO table, the 1980 CSO table, and now the 2001 CSO table are its successors. While the American Experience table and the early versions of the CSO table were used for many actuarial purposes, the recent versions of the CSO table have become less far-reaching.

Over the last several decades, companies have relied on their own experience or that of reinsurers for the purpose of pricing and other best-guess actuarial activities. Today, the CSO tables are primarily used for statutory regulation and federal taxation purposes. The tables are used to establish statutory reserves, minimum cash-surrender values, and the maximum mortality rate that can be levied within a universal life policy. Within the tax arena, the tables are used to establish the maximum level of funding permissible in order to qualify as life insurance, and they are used to establish the funding threshold for modified endowment contracts.

The 2001 CSO rates are mostly lower. What does that mean to the typical consumer? The new rates will not have a significant impact because, as noted, the mortality tables that drive policy pricing are derived from actual company experience or the mortality quotes offered by reinsurance companies. There are some indirect pricing impacts, but these are not as great as some articles have suggested and what most laypeople would expect.

Let's examine how 2001 CSO rates may affect new policies.

Protection-Oriented Products

Term insurance and universal life (UL) with no-lapse secondary guarantees fall into this category. Because lower mortality rates generally result in lower reserves, one would expect that these products—where reserve efficiency has a significant impact on premiums—would reap the largest benefits from switching to the new table. While theoretically correct, the most aggressive companies had already found creative ways to minimize reserves prior to the adoption of the new table and will likely not be able to adjust their premiums further downward. Companies that have not employed such creative strategies will likely implement a modest decrease in the premiums for their protection products.

Accumulation-Oriented Products

These policies have robust premiums relative to the initial death benefits and generate large cash values. UL, whole life, and variable policies fall into this category. This is the area where consumers will be affected the most and, ironically, the overall decrease in the table is actually to the consumer's detriment. In an accumulation design, it is most efficient to minimize the net amount at risk—the difference between the death benefit and the cash value. Both the definition of life insurance and the definition of a modified endowment contract rely on formulas that use the prevailing CSO table. The adoption of the 2001 table means that more death benefit will be required for every dollar of premium that is put into a contract—exactly opposite from what would be desirable for the most efficient accumulation.

It appears that some companies are delaying the introduction of their 2001 CSO-version accumulation-oriented products until the last possible moment, so consumers generally have not yet seen the impact on new product designs. And we should also not be surprised if there is somewhat of a fire sale on accumulation-oriented products over the next few years, as more consumers and advisors become aware of the impending changes.

Summary

The adoption of the 2001 CSO table has triggered a tremendous amount of product development across the industry, and those products will be hitting the streets over the next several years. While consumers seeking protection-oriented products may see modest premium decreases in some instances, the most aggressive companies have already manipulated their pricing to get this same effect. On the other hand, consumers seeking accumulation-oriented products will discover that the new table will have an adverse impact on their ability to overfund contracts and maximize accumulation efficiency.

In-force policyholders will not be affected by the new table, and consumers should be wary of claims that they should replace existing coverage simply because a new table has been adopted. A thorough review may indeed indicate that replacement is a good idea, but in all likelihood the new table will not be a factor in that decision.

Reprinted with permission by the Financial Planning Association, Journal of Financial Planning, Volume 19, Issue 3, March 2006.

Peter Katt, CFP, LIC, sole proprietor of Katt & Co., is a fee-only life insurance adviser located in Kalamazoo, Michigan (269.372.3497).